UPDATED: Mar 26, 2020
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When you’re a business owner, planning for the future and providing financial security to your family can become a bit complicated. But nobody said it would be easy, right? You need to do a lot of things on your own, including finding insurance to ensure your loved ones have peace of mind and receive their fair share of the business if anything would happen to you.
Sadly, only about one in three small businesses have life insurance on their owners.1 If you’re one of those who doesn’t, I’d guess the subject has at least crossed your mind.
The Basics of Buy-Sell Life Insurance
Buy-sell is one of the four main types of business life insurance (available as both term life and permanent life insurance) that can help protect your family if the unthinkable happens to you. Administered through an attorney, a buy-sell agreement defines what should happen to a business after an owner or partner dies.
While some businesses stay in the family after the death of a business owner, not all families want to remain in a business after the owner has died. For companies with multiple partners, a buy-sell life insurance policy arranges for remaining owners to buy out a deceased partner’s stake in the business. It helps ensure the continuity of a business and enables a deceased owner’s family to receive equity without continuing as owners.
With buy-sell life insurance, all owners/partners pay the premiums. If a partner dies, the policy provides a death benefit to the remaining partners.
Insurance companies typically determine the amount of a buy-sell policy by looking at the Fair Market Value of a business. To decide how much coverage each owner should have, they consider the ownership percentage of each partner. Both the company’s buy-sell agreement drawn up by its attorney and the business’s financial statements help insurance companies determine the details of the buy-sell life insurance policy.
Buy-sell arrangements come in a variety of flavors because every business has unique needs. Businesses of all sizes—sole proprietorships, partnerships, and even corporations—can benefit from having a buy-sell arrangement in place.
Types of Buy-Sell Agreements Funded by Life Insurance
No-Sell Buy-Sell Agreements – This arrangement sees that management of the company goes to the surviving owners while also ensuring the deceased owner’s family or estate benefits from the appreciation in the business’s value in the future.
Entity Purchase Agreements – With this agreement, the business will buy the deceased owner’s interests. The business is the applicant, owner, and beneficiary of the life insurance policy on the owners.
Cross-Purchase Agreements – In this arrangement, surviving owners agree to purchase a deceased owner’s interest in the business. Each business owner is an applicant, owner, and beneficiary of the insurance policies on the other business owners.
Wait-And-See Buy-Sell Agreements – These flexible agreements allow business owners to wait until a death occurs to decide whether the owners or the business should buy the business interest. These policies can be applied for, owned, and paid for by the business, the owners, or both.
If it seems like that’s a lot to think about, it is! And we’ve covered just the tip of the iceberg here. Each form of buy-sell agreement has its advantages and disadvantages to consider. As you think about which type will best protect your family and your business, talk with a qualified attorney and life insurance professional for their inputs and advice.
1According to LIMRA’s Small Business Ownership Study in 2008